Behavioral finance and portfolio management: Review of theory and literature

Abstract

Crowd psychology and cognitive biases are the outcomes of irrational behaviors. Identifying the irrationality in the behavioral patterns can reduce the market anomalies that we are facing in the stock market operations. Researchers have developed the behavioral portfolio model, which is a prescriptive model by incorporating the behavioral biases. The model was developed as an extension of capital asset pricing model. The behavioral portfolio model explains why the investors invest with multiple objectives such as future requirement of family, retirement saving, and fund for meeting emergency. Application of behavioral finance will help in policy making process by designing optimum portfolio and strategies to minimize the risk by controlling the emotions of the investors.